Shareholders appeared to be happy with DXC Technology Company's (NYSE:DXC) solid earnings report last week. This reaction by the market reaction is understandable when looking at headline profits and we have found some further encouraging factors.

Check out our latest analysis for DXC Technology

Zooming In On DXC Technology's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, DXC Technology recorded an accrual ratio of -0.17. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of US$994m during the period, dwarfing its reported profit of US$24.0m. DXC Technology shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

DXC Technology's profit was reduced by unusual items worth US$88m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect DXC Technology to produce a higher profit next year, all else being equal.

Our Take On DXC Technology's Profit Performance

In conclusion, both DXC Technology's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think DXC Technology's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you want to do dive deeper into DXC Technology, you'd also look into what risks it is currently facing. To help with this, we've discovered 2 warning signs (1 is a bit concerning!) that you ought to be aware of before buying any shares in DXC Technology.

Our examination of DXC Technology has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.